Cyprus at the Crossroads

The economic, political and social situation in Cyprus remains mixed. Although Cyprus has exited the bailout, it is clear that the reform drive of the government had faltered, and that political support by other political parties has fractured. And while some very positive investments have been announced, the economy remains dominated by three sectors and economic headwinds, such as declining competitiveness and a high non-performing loan stock remain unaddressed.

This article reviews some of the major developments in different areas of the Cypriot economy. It concludes that headline numbers aside, unless Cypriot voters and citizens are prepared to make difficult decisions about the future of the country, Cyprus will remain far behind realising its true potential.

1.Political Situation

The political scene in Cyprus is currently dominated by three main issues:

1.Political Alienation and Fragmentation

2.The Reunification Negotiations

3.The 2018 Presidential Election

1.1Political Alienation and Fragmentation

The 2016 Parliamentary elections were characterised by an unprecedented abstention rate. Only 66% of voters, or 362,542 turned out to vote: Some 33% of voters abstained from the elections. This reflects widespread voter dissatisfaction with the choice of political personalities and parties, but also the lingering effects of the economic recession.

The result of this low turnout has been to increase fragmentation in Parliament. The Cyprus House of Representatives currently has 8 political parties represented, up from 6 in the previous Parliament. The largest party, DISY, has only 18 seats in the 59-seat House . For the first time, a far-right party, ELAM, entered Parliament with 13,000 votes and 2 seats.

This fragmentation makes it almost impossible for the governing coalition, which now only numbers 2 parties, to pass legislation or address the critical issues facing the country today. This weakness has set the stage for many of the relative failures that will be discussed in this article.

Exhibit 1: Seats in Cyprus House of Representatives, 2016 [1]

Table 1: Composition of Cyprus House of Representatives & Vote Share

Political Party

# Votes

Share, %

# Seats

Democratic Rally (DISY)

107,825

31

18

Progressive Party of Working People (AKEL)

90,204

26

16

Democratic Party (DIKO)

50,923

14

9

Movement for Social Democracy (EDEK)

21,732

6

3

Citizens' Alliance (SYPOL)

21,114

6

3

Solidarity Movement (KA)

18,424

5

3

Ecologists - Citizens' Cooperation (KOSP)

16,909

5

2

National Popular Front (ELAM)

13,041

4

2

Total Elected

340,172

97

56

Registered Voters

543,186

1.2 Reunification Negotiations

President Anastasiades has made a determined effort in the reunifications negotiations. The President has personally engaged in this process for over 2 years and expended significant political capital on the process, culminating in a series of bilateral and multilateral meetings in Pelerin, Switzerland, under the aegis of the United Nations. [2]

This process has recently been disrupted by a Cyprus vote in Parliament instructing the Cypriot school system to commemorate the 1950 referendum for Enosis, or unification with Greece. [3] This referendum, which predates the foundation of Cyprus as an independent state in 1960, was carried out solely by the Greek Cypriot community, and was not recognised by the Turkish Cypriot community or by Britain, which was the colonial authority in Cyprus at the time. It is also one of the reasons why the Turkish Cypriot community sought protection from Turkey.

This vote was introduced by ELAM, the far-right party with links to Greece’s Golden Dawn Party, and passed with AKEL voting against, but with DISY, the ruling party, abstaining on it.

Predictably, this vote was viewed unfavourably by the Turkish Cypriot community. The leader of the Turkish Cypriot community, Mustafa Akinci, broke off negotiations and issued a demand that the House of Representatives cancel the motion.

It must be mentioned that the Pelerin negotiations were already stalled due to the fact that of the 8 political parties in the House, only two supported them: DISY and AKEL.

The result of this motion is probably that the negotiations will have been stalled, at least until Presidential elections in 2018 are completed. However, it is not certain what happens then, as political trends in Turkey appear to be worsening.

1.3Presidential Elections

The next presidential elections in Cyprus take place in 2018. As such, it is highly anticipated that President Anastasiades, beset by both a minority in Parliament and the break-down in the Reunification negotiations, will hold off on making difficult restructuring decisions until then.

To DISY’s credit, it did try to introduce measures eliminating parastatal organisations, but these were voted down in Parliament. This is discussed in further detail in the following sections.

2.Macroeconomic & Fiscal Update

Among the positive developments in Cyprus are that the economic recovery appears to be picking up speed, driven by tourism, property and financial activity. Despite the positive headline growth, however, Cyprus continues to lose its position in terms of competitiveness, indicating the need for structural reforms to be continued.

2.1Gross Domestic Product (GDP)

Cyprus GDP recorded a 3.0% increase in QIV 2016 over QIV 2015. In terms of constant prices, Cyprus GDP will (absent revision), record an increase of over 2% in 2016. GDP quarterly growth has now been positive since Q2 2015.

2.2Unemployment

Unemployment in Cyprus continues to fall. Seasonally-unadjusted unemployment rolls show that in February 2017, there were 42,326 registered unemployed, versus 45,961 in February 2016 and 50,240 in February 2015.

There are also signs that the employment rate and labour force are expanding. In QIII 2016, the employment rate expanded to 54.5%, up from 51.8% in QI 2016. While this shows the inevitable impact of seasonality on employment (the summer represents peak employment in Cyprus due to tourism arrivals), it also shows the need to expand the employment rate.

Between 2004 and 2010, the Cyprus employment rate was at 60% or higher. Since then, it has plunged to 53%, reflecting the impact of the financial crisis.

Exhibit 4: Cyprus Employment Rate , 15+ [8]

Notes on Data:

• 2004-2015 data based on annual averages

• 2016 datum is the average of QI – III calculated by the author and do not represent full-year data

It should be remembered that in a healthy economy, not only is unemployment low, but the employment rate is high. In Germany, for instance, the employment rate was 74% in 2015. Raising the employment rate is a key challenge for Cyprus, and one that institutions such as the Human Resources Development Authority (HRDA) have been working on with various schemes to promote employment.

2.3Fiscal Balance

Some very positive news is that the central government budget balanced in 2016 for the first time since 2008. According to Ministry of Finance data, central government revenue was € 6.67 billion, versus expenditure of € 6.25 billion, for a surplus of € 421.50 million. Responsibility for achieving this surplus rests entirely with the Anastasiades government, which has been making heroic efforts to balance the state budget since inheriting a disastrous fiscal situation in 2013.

Exhibit 5: Cyprus Government Balance [9]

Notes on Data:

• Data 2000 – 2015 from Eurostat

• Data 2016 from Cystat , calculations by author

2.4Competitiveness

A final note on the economic situation, it is important to note that Cyprus has lost significant ground in overall competitiveness. The World Economic Forum generates the World Competitiveness Index every year, based on 12 factors ranging from Institutions and Infrastructure to Higher Education and Technological Readiness to Business Sophistication and Innovation.

What is extremely worrying is that Cyprus has been losing ground steadily in these rankings since the 2009-2010 version of the report. In the 2016-2017 Report, Cyprus is ranked at 84. This is significantly below other international business centre competitors such as:

•Switzerland (1)

•Singapore (2)

•Netherlands (4)

•Hong Kong (7)

•United Arab Emirates (17)

•Luxembourg (20)

•Ireland (24)

•Malta (40)

•Mauritius (45)

•Latvia (49)

Moreover, despite making a concerted effort at public sector reform, Cyprus’ position actually declined between 2015-2016 and the 2016-2017 Report, falling from 65 to 83. In 2009-2010, in contrast, Cyprus ranked 34 worldwide.

Why is this important? Although we can argue with specific points of the Competitiveness Index, it does represent an externally-applied measure of fundamental competitiveness that is applied world-wide.

Cyprus is a small economy that depends on external investment and trade. To see rapid and consistent downward movements in its competitiveness rankings at the same time as it is implementing a structural reform programme should raise considerable alarm. Particularly given the competition it faces from other international business centres such as Malta, Ireland, Mauritius, and Luxembourg, with whom it competes head-to-head for corporate investment.

3.Other Points

There are several positive points going on in Cyprus today:

Tourism arrivals reached record levels in 2016, with further increases predicted in 2017.

The casino investment has finally been licensed. A consortium led by Hard Rock has begun work on a main casino in western Limassol, with several satellite installations around Cyprus.

Other investments, including Pafilia’s One or the Leptos Del Mar building, are underway. Marinas are under development in Aghia Napa and Protaras, and a recent court case for the Paphos Marina has been resolved, leading to the anticipated start of that project.

The Third Licensing Round for oil and gas exploration was completed, with three consortia licensed: Block 6 by ENI Cyprus / Total E&P; Block 8 by ENI Cyprus; and Block 10 by ExxonMobile and Qatar Petroleum.

The Bank of Cyprus successfully listed its shares on the London Stock Exchange, and also announced that it has successfully repaid the large majority of Emergency Liquidity Assistance (ELA) loans.

The government recently passed a Start-up Residence Permit scheme, whereby innovative teams investing a minimum of € 50,000 in Cyprus could receive a residence and work permit.

But there are also a number of challenges and negative developments

This month, after refusing for over two years to meet their demands, the government gave in to a new collective bargaining agreement for nurses in the state medical sector. This agreement will see their wages rise via recognition of their nursing degrees. Predictably, numerous other public sector professions have followed suit, requesting higher wages.

A recent government attempt to restructure loss-making parastatal organisations, including the Grain Marketing Board, failed when opposition parties voted against it.

Other attempts at privatisation have stalled. AKEL submitted a motion to abolish the Privatisation Unit. Other decisions have slashed its funding. Few major privatisations are now considered realistic.

The privatisation operation of the port of Limassol by Eurogate has resulted in significant disruption of activities, culminating in a strike of port workers on the weekend of 18-19 February. Different reasons have been given for the disruption, but it is apparent that the introduction of new, higher tariffs, together with equipment problems, have led to a serious slowdown in container loading and unloading. Together with other attempts to slow privatisation, this does not bode well for the future.

The stock of non-performing loans has fallen to below € 25 billion. However, this is still well above GDP, and there are many indications that the handling of NPLs has stalled. Properties that have been foreclosed or worked out and are now handled by the Bank of Cyprus Real Estate Management (ReMu) unit, for instance, are still listed at illogically high prices.

4.Cyprus at the Crossroads

These points prompt an external observer to raise a number of points as to Cyprus’ future direction.

What social and business model will Cyprus follow? Does it really believe its ambition to be an open, innovation- and service-drive economy, such as a “Singapore of the Mediterranean”? Or will it follow Greece down the path of inefficient parastal control of the economy, low productivity and low growth?

In case Cyprus wants to realise its ambition of being a growth centre, then what future course of the reform process will take place? What is the appetite for structural reforms, given that the Troika loan disbursements and monitoring have ended, and that public sector pressure for wage increases have resumed

Given the difficult political fragmentation of Cyprus, what will happen with the 2018 Presidential elections and the 2021 Parliamentary elections? Can we expect a political consensus on the difficult reforms needed, or will Cyprus lapse back into the political horse trading that caters to public sector unions and other special interest groups?

The Cypriot economy remains dominated by three sectors: tourism, financial services and property. Tourism remains vulnerable to external shocks, and has been growing due to regional difficulties. The financial services sector remains strong, but remains exposed to reputational risks (such as potential failures in the Forex sector) as well as further regulatory action again transfer pricing and automatic exchange of information within the OECD and Eurozone. The property sector is currently driven at the top end by investor citizenship and residence programmes, which are likely distorting the true profitability and demand in the sector. What happens if one or more of these sectors encounters difficulty? What is the next step in meaningful economic diversification?

Is there space for innovation and digital transformation in the Cyprus economy? With many economic sectors dominated by a handful of large family-owned groups (finance, retail, property), where will the drive for innovation come? Will Cyprus be able to catch up with fast-evolving economies in northern Europe in terms of digital and service innovation, or will it continue to lag behind?

Will there finally be a political solution to the Cyprus problem? Or will fringe political parties continue to block the process for their own political goals? Should the UN continue to engage in this process? Can Turkey be trusted as a political interlocutor?

None of these questions can easily be answered absent a clear social consensus on the future direction of the country. Unfortunately, the last Parliamentary elections shows that voter anger and apathy have reached historic levels, while political fragmentation has never been so high.

This is why Cyprus is at a crossroads. A weak coalition government will continue to pass piecemeal laws, and Parliament can continue to water down and defeat reform. Tourism and foreign investors in Cyprus companies and citizenship may continue to keep the economy rising. Reforms will halt now as President Anastasiades and his political competitors prepare for the 2018 presidential elections. A new coalition government will likely have to be negotiated in February-March 2018.

But it is clear that in a very dynamic and fast-moving world, the current system of politics and governance leaves much to be desired. Only if voters demand change and vote accordingly can the deep-rooted problems of declining competitiveness and public sector stagnation be reversed.